India must face up to some harsh economic realities

Labourers work at the construction site of a bridge being built for metro rail in New Delhi, India. Anindito Mukherjee/ Reuters

India is battling to boost a stagnating economy in the wake of the shocks of demonetisation and the introduction of a new sales tax.

“There are concerns,” says VK Vijaykumar, the chief investment strategist at Geojit Financial Services, headquartered in Kochi in Kerala. "Action is needed if India is to try to get near its growth targets."

India's GDP slowed to a three-year low of 5.7 per cent in the April to June quarter, a sharp decline from the 7.9 per cent recorded in the same period a year earlier, according to the government. India's economic survey report released in January had forecast growth of 6.5 per cent to 7.5 per cent for the current financial year.

Ministers and top officials, chaired by the country's finance minster Arun Jaitley, gathered on Tuesday for talks on the state of economy and to work out possible ways to revive growth, as concerns mount over the slump. A couple of years ago, Mr Jaitley spoke about targets of GDP growth of 8 to 10 per cent being achievable.

Wednesday he said said that any required measures would be announced once they had been discussed with India's prime minister Narendra Modi.

Steps that New Delhi might take that could help include investment into major infrastructure projects and incentives to boost flagging exports, analysts say.

India's current GDP figures may seem enviable by comparison to levels in the likes of Europe and the United States, but as a developing country with a population of 1.3 billion, the country needs to sustain higher levels of growth to create much-need jobs for its young population.

Reuters has reported that the government is mulling a plan to ease its fiscal deficit target and spend 500 billion rupees (Dh28.35bn) more this year - on areas including bank recapitalisation - to stem the economic slowdown, according to government sources.

A new report by Deloitte reveals that India is in a position to become an economic superpower because of its young demographics, while the populations of countries including China are set to age. As a result, India will account for over half of the expansion of the workforce in the region in the next decade, according to Deloitte.

India last year was the world's fastest growing major economy, but this year it has lost this title to China.

This does not bode well for the predicted rise of India. The slowdown is considered a major challenge to the government, with Mr Modi's BJP party coming to power in 2014 in a landslide victory following a campaign that promised the party would improve the economy.

The former finance minister P Chidambaram from the opposition party took to Twitter to describe the latest GDP figure as "a catastrophe".

The next general elections are due to take place in 2019, adding to the pressure on the ruling BJP party to turn around the decline. The weakness also comes against a backdrop of rising oil prices, with India being heavily dependent on crude imports. At the same time, banks in the country are struggling under the weight of bad debt.

“The Modi government has administered two rounds of shock therapy to Indian economy: demonetisation and tax overhaul,” says Mahesh Singhi, the founder and managing director of Singhi Advisors, an investment banking firm based in Mumbai. “While both moves may pay off in the long run, their toll on the economy has been higher than initially anticipated.”

In November, Mr Modi announced that the two highest value 500 and 1,000 rupee bank notes would be scrapped, a move aimed at curbing black money flows. This resulted in a cash crunch, and many businesses say they are still feeling the impact.

Then in July, India launched its long-awaited goods and services tax (GST), a uniform tax regime introduced across the country replacing the multitude of levies found across different states in the country, which has had a negative effect as businesses continue to try to adapt to the new system.

“Definitely the impact of demonetisation on businesses has been large and visible and didn't recover,” says N Chandramouli, the chief executive of TRA Research, a data analytics firm in India. “Surprisingly GST, while it's meant to be good in the long run, has had a huge impact. It requires taxes to be paid almost in advance every month ,even if you haven't received payments from the client, so it's taken cash flow away from businesses. They're not able to do anything new. I know companies that have delayed salaries because of it.”

The negative impact across businesses “is not going any time soon”, he says, adding that “it's a downward slide for another two quarters at least”. He adds that he would like to see the government collaborate with industry on the kinds of steps that could be taken to improve the economy.

How the authorities now opt to manage the slowdown will be critical and investors and firms are watching closely, analysts say.

“The way the government goes about doing its task is as important as whether they actually achieve it,” says Mr Singhi.

A cabinet reshuffle earlier this month saw Mr Jaitley handing over his title of defence minister to Nirmala Sitharaman, while retaining his title of finance minister.

The move allows Mr Jaitley “to focus solely on the economy ... [and] will help further convince that Modi’s working to reverse the growth slump”, says Mr Singhi.

Soumya Kanti Ghosh, the chief economic adviser at the State Bank of India in a report warns that the slowdown in the country's economy is “technically not short-term in nature or even transient”.

This means that the India's GDP growth has fallen over six consecutive quarters.

Mr Ghosh in the note says that that more public spending is “the need of the hour … to grow more”.

But considering the limitations and cost of increasing public spending, some economists argue that a more effective initiative to restore the health of the economy could be rupee depreciation.

Mr Vijaykumar says this would lend much-needed support to exports and increase industrial production by reducing dependence on imports.

"The Reserve Bank of India has to buy dollars and depreciate the currency,” he says.

There are a number of experts who remain confident that GST will benefit India is the long run and that India will see a pick up in the economy.

The World Bank's India director Junaid Ahmad recently described GST as a “tectonic shift” which will make GDP growth of 8 per cent and above possible for the country, according to the Press Trust of India news agency.

Mr Singhi describes the situation as “a short term glitch, as we move towards a more formal, digitised economy and tax base is being widened”, adding that demonetisation and adjustment to the new tax regime “are temporary disruptions and the effects should start dissipating this quarter”.

Mr Singhi points to the Indians stock market as an indicator that investors still have faith, with stock markers rallying to a series of record highs this year.